This paper proposes a novel structural model to estimate the equilibrium level of output and reports results for 45 countries. The model is conceptually more appropriate than existing methods by incorporating open economy considerations, which are completely missing from the models of the European Commission, IMF and OECD.
In this post Zsolt Darvas presents an analysis of the revisions made to output gap estimates between 2001 and 2015 by the European Commission and the IMF. The output gap shows the difference between actual output and potential output, where the latter should represent the output that could be produced if all resources were employed at their long-term sustainable rate.
The so-called structural balance of the general government aims to measure the ‘underlying’ position of the budget by excluding the impact of the economic cycle and one-off measures, like bank recapitalisation costs. It has a crucial role in designing fiscal consolidation strategies in the EU (see the Annex at the end).
What’s at stake: The big issue underlying most macroeconomic discussions these days is the extent to which the decline in GDP is temporary or permanent. To distinguish between these two alternative explanations, it is natural to look at the behavior of inflation. The argument is that if the economy is operating significantly below potential, inflation should be decreasing, while it should be increasing if the drop in output is permanent. As we point out in this issue, this exercise is, however, harder than it looks because of the presence of downward nominal wage rigidities, anchored inflation expectations and the possibility of temporary decline in potential output.
What’s at stake: What started as a speech on inflation targeting by the President of a regional Fed has turned into a fierce economic debate on the impact of the collapse of a bubble on potential GDP. While it is natural for the current debate to focus on this phase of the problem, a growing literature has also explored the impact of bubbles on potential GDP during the boom phase. We start by reviewing the provocative body of work that studies bubbles in the presence of financial frictions, which often come to the conclusion that bubbles can increase potential output by reducing the inefficiency induced by financial market frictions. We then review the current debate on the econ blogosphere following the infamous Bullard speech. Although the arguments are somewhat decoupled from the ones we outline in the first part and focus on more familiar ideas, it is interesting to see that a Fed regional President played by the rules of the econ blogosphere and wrote his own “geeky” post as a response to the criticisms he had received.